Finance Regulations to Watch in 2013: International Speed Bankruptcy & U.S. Crowdfunding

1. U.S. and UK regulators are trying to find a workable way to shut down big international banks. If they find a solution it would remove one of the the big barriers to ending Too Big To Fail. FT's Lex reported in early December ($):

US and UK regulators will unveil the first cross-border plans to deal with failing global banks on Monday, outlining proposals to force shareholders and creditors on both sides of the Atlantic to take losses...

Later Lex quotes the joint U.S.-UK working paper while adding appropriate commentary:

[U]nsecured bondholders "can expect that their claims would be written down to reflect any losses that shareholders cannot cover", which did not happen when the US and UK had to prop up their international banks in the 2008 crisis.

Even if we had hard-nosed regulators in power (I don't know the key players so I can't judge) it would be difficult to push the button on massive debt writedowns in the middle of a financial crisis. Many dress rehearsals will be necessary before we can be sure the show will actually go on. But it's looking like financial regulatory elites are moving in the direction of speed bankruptcy. Maybe someday we'll actually get there.

2. This year Americans lost the freedom to legally invest in Intrade. At some point this year (maybe next) the same SEC that removed that freedom is supposed to release regulations on another web-based financial innovation: Crowdfunding, a way for people with big ideas but little cash to ask people to chip in to a new project.

I hope SEC permits this innovation to continue but the Intrade decision is worrisome. This NYT article by Robb Mandelbaum highlights two rules that if strictly imposed could cripple crowdfunding: Requiring that organizations "raising more than $500,000 provide investors with audited financial statements," and requiring crowdsourcing websites to ensure that investors aren't using various gimmicks to put more cash into crowdfunded startups than permitted by law. How much effort should a firm have to make to ensure that it isn't selling too much of its own product?

Salon and Forbes have also covered the regulatory issues around crowdfunding in recent months. Being trendy didn't save Intrade but maybe it will save crowdfunding.

Let's hope that the relentless quest for safety doesn't get in the way of genuinely risky financial innovation. Let's create an alternative method to fund new ideas beyond banks, home equity, and bugging your relatives.

I may be mistaking crowd funding in general for the specific case of Kickstarter, but it seems to me that it has an easy way around in that it is not selling investments so much as pre-selling the eventual product and providing additional artifacts surround the creation.

If there are crowd-funded investment opportunities that rely on the possibility of profits, I could see the deal structured to avoid a direct definition of investment.

In the long run this may be the investment equivalent of naked Shakespeare, though.

Kickstarter is one of the neatest things on the net that I've seen in a while. I really hope it's not wrecked by regulation.

I think Kickstarter is less of a frontal attack on the sanctity of our cherished blah blah blah than Intrade was with the election wagers. I hope--not too optimistically--that Kickstarter won't draw any serious attacks until somebody with clout is ready to take their part.

Granite, I don't understand the naked Shakespeare remark--want to explain?

Here's a fun idea: Remove legal protection against liability for company debts from shareholders. You can make the argument that unlimited liability would make investors too wary to invest but this doesn't hold up historically. Britain's original industrial revolution was funded without the benefit of limited liability. Unlimited liability can seem like an impediment for small investors but again 18th century Britain offers a solution: Anonymous shareholding. If courts don't know you're a shareholder, they can't go after your assets to help pay company debts.

Now, this introduces some problems in the relationship between the shareholder and the company. I happen to feel these problems are perfectly incentive compatible: If you're an anonymous shareholder, the company can stiff you on dividends and there's nothing you can do about without giving up your anonymity to sue them in court. However, you do always have that option and the company knows it.

Anonymous shareholdership would be about balancing the risk that the company would screw you over with the returns you receive from the shareholdership. Offering anonymous shares would be about balancing your ability to screw over shareholders with the need to havae shareholders in the first place -- a company which acquires a reputation for stiffing its anonymous shareholders would quickly stop being able to sell a large portion of its stock, exerting a downward pressure on stock price.

This kind of shareholder liability seems to be what they're looking at doing anyway from that second quote. They're just emulating the unlimited liability that existed before the adoption of general incorporation laws made limited liability widespread. Then again, that's pretty much all government: Emulating something that would exist anyway.

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